Sometimes expenses overwhelm possible tax savings

I’m at a crossroads. I just turned 70, am a woman and have been divorced for many years. For 10 years I’ve worked for the state, but I realize that could change at any time. I take home $1,650 a month. If I retired right now, which I could, my retirement check would be about $650 a month, plus free medical benefits. My Social Security is about $2,050 a month.

I have two houses. The one I live in is in a part of town I no longer want to live in. Principal, interest, taxes and insurance are about $1,037 a month, and I have been living here for three years.

I have a second house that has been leased for seven years because the payments got too big. The rent covers the principal, interest, taxes and insurance, but since the house is 18 years old, it requires expenditures for upkeep — $7,000 last year. Before I could sell it, it would be best to live in it for two years to help with the taxes on the capital gain when sold. It has about $150,000 in equity, which would be reduced by taxes on the capital gain and depreciation taken.

I would love to move back into this house for at least two years but cannot see how I could afford it. I have $50,000 in an IRA and will be receiving an inheritance of about $50,000 at the end of the year. I have about $25,000 in credit card debt. What do you think?

F.D.

It may cost more to move back to the original house for two years than you would save in taxes on the capital gain. You’ll only know for certain by doing some close figuring of how much more you will spend to support the older house for the two years you would be living in it. That $7,000 in repair bills, for instance, is about equal to the tax on about $47,000 of capital gains. A better plan would be to focus on your long-term shelter goal and figure out the lowest-cost way to get there.

How do you figure your pension and Social Security in calculating net worth? They are assets. If I were to take a million dollars in assets and buy an annuity, would my net worth go from a million to nothing?

P.T.

Pensions and/or Social Security are very valuable. But they can’t be considered assets because both are only guaranteed income streams, not assets you can buy or sell. And, yes, if you took a million dollars in financial assets and bought a life annuity, that million would come off your personal net worth. So think of a pension and Social Security as “virtual assets” — income rights that you have that can profoundly influence your personal security and how you invest your money.

Consider this puzzle. Twin brothers take different career paths. One is a university professor and is entitled to a pension and Social Security that replace his entire final salary, so he is wondering how to invest his $200,000 in 401(k) money.

The other becomes a doctor in private practice. He earns more than his brother and can retire with Social Security, but it will only replace 15 percent of his pre-retirement income. The remainder of his retirement income has to come from $2 million in his retirement plan.

Which twin should be more conservative?

Answer: the doctor.

The professor can invest in high-risk investments because his lifetime income is already secure. Equally important, his lifetime spending won’t change much, regardless of the results of his $200,000 investment.

The doctor, meanwhile, will have to be more conservative because 85 percent of his needed income will come from his investments. So he must be prudent. For him, losses or gains in his portfolio will have a big impact on his lifetime income.

Another factor is debt. If you retire with no debt, you can invest more aggressively than if you have a fair amount of debt.

Both of these factors — increases in debt at retirement and fewer guaranteed pensions — are reducing retirement security for younger workers. And that doesn’t count the willingness of both political parties to consider reducing future benefits of young workers.

Scott Burns is a syndicated columnist and a principal of the Plano-based investment firm AssetBuilder Inc. Email questions to scott@scottburns.com.

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